A federal judge Thursday upheld a cable company's $3.50 monthly rate increase for Fullerton's 16,500 subscribers and rejected the city's claim that it had the power to block such increases.

U.S. District Judge Irving Hill in Los Angeles ruled that Fullerton's ordinance prohibiting rate increases without council approval is invalid because it conflicts with state law.

Fullerton sued Group W Cable in April after the firm announced plans to unilaterally raise the price of basic city service from $6.45 to $9.95 per month, effective June 1. For some customers--those who rent a cable decoder box for $1.50--the change translated to a $2 increase.

The franchise ordinance calls for City Council approval of any rate increase, and in its contract Group W waived its rights under state law and agreed to seek council approval before implementing rate increases.

Hill ruled, however, that under state law cable companies are not subject to municipal control of rate increases if they meet certain criteria, such as having been in operation for two years and providing at least 20 channels, including local programming channels for public access.

"A contract is a contract and we have a responsibility to protect the public," Fullerton Mayor Allen (Buck) Catlin said Thursday. "I think they ought to adhere to their contract."

Judy Shane, Group W public affairs director, said the state law was designed to deregulate some portions of the cable business.

Fullerton Case Unusual

"It's an industry, like anything else," and not a public utility that should be regulated, Shane said.

The Fullerton case is unusual because most cities have recognized that state law governs, despite local legislation to the contrary, according to Carl Pilnick, president of Telecommunications Management Corp., a Los Angeles private consulting firm to the cable industry.

"Most cities have given up in California," Pilnick said. "Most have resigned themselves to the fact that's an area they can't control anymore."

But William Marticorena, an attorney for Fullerton, said the city may appeal Thursday's ruling because the judge's decision "creates so much uncertainty."

"Group W, in a matter of contract, told the city it would do something. The city gave them that franchise on those conditions," Marticorena said. "If a cable operator is free to choose those conditions it wants to honor and those it doesn't want to honor, there is no way a city in the future can negotiate."

Elsewhere in Orange County, Group W's right to raise prices has been recognized.

In January, Santa Ana City Council members agreed to alter their contract with Group W to allow a rate increase and a reduction in services, ending a long dispute.

Last week, Newport Beach City Council members gave tentative approval to deregulating their two cable companies--Group W and Community Cablevision--following a rate increase request from Group W, City Manager Bob Wynn said.

Officials in Newport Beach and Santa Ana cited 1984 federal legislation which will free cable firms from all price control by December, 1986.

Chris Meyer, assistant to the Fullerton city manager, said officials "still get an occasional call" from disgruntled residents complaining about the increase that took effect June 1.

Decision Pleases Firm

Group W officials argued that this is the first rate increase for the city's subscribers since the company bought the old franchise--TelePrompter--in 1982. Group W has 67,000 subscribers across Orange County in the cities of Buena Park, Fullerton, Newport Beach, Santa Ana, Seal Beach and Placentia, district manager James W. Bequette said.

"Group W is pleased with today's decision," Bequette said, reading from a prepared statement. "We attempted to resolve Fullerton's contentions on a business-like basis and we're disappointed that the city believed court action is necessary. We anticipate that Fullerton is now assured that our mutual objectives are consistent with lawful deregulation and that our continuing business relationship will be positive."